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Retirement calculations: Determining how much you'll spend in retirement
Most persons (if not all) cannot see into the future, but everyone can use the present as an indicator of it. Some persons say that retirement planning is not that important because they won’t be doing much in retirement. However, just living yields certain expenses, and these must be covered anyway. Soon, that “tomorrow” will be “today” and the reality of the challenges of retirement must be faced.
Estimating how much you may spend in retirement is vital in estimating how long your life savings will last. This information facilitates planning and would leave individuals in a better position to cover future expenses adequately. The following factors are necessary in calculating your retirement needs:
a) Retirement income
b) Retirement expenses
c) The projected annual withdrawal from your retirement fund
d) Inflation rate
Gauge current expenses and project future expenses
The first step in this process is gauging your current expenses realistically. This can be done by taking your current monthly or annual budget, analyzing it and determining what percentage of your pre-retirement income you'll need to survive comfortably in your golden years.
Your pre-retirement income and expenses would be projected using the inflation rate, the number of years left until retirement and current income/expenditure levels. It is also critical to discount or add costs that may not or may exist at the time of retirement. Financial advisors suggest leaving a buffer for medical/health expenses that may arise after you retire.
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The concept of prudence in determining retirement expenses
Prudence in financial management suggests that it is better to over-estimate than underestimate liabilities and expenses. After all, additional savings may act as a buffer in the event of contingent events and circumstances.
Prudence also applies to anticipating increases in expenses during retirement due to increases in the cost of living. This can be done by conducting a post-retirement analysis based on initial projections of your income and expenses. However, the pre-retirement estimate should be used as the base spending amount. You can then determine retirement spending in two primary ways:
i) As a defined fraction of pre-retirement income
It is usually more prudent to index retirement spending to retirement income. Restricting your spending levels by establishing spending limits are also sound strategies. The spending limit may be your annual rate of withdrawal from your accumulated retirement fund. This can be used alongside percentage of income to be spent, which would help you to determine what your nominal and real spending would be in retirement.
Inflation, withdrawal rates and retirement income are critical in estimating how much you may possibly spend during retirement. How much you will spend should also be influenced by your financial means and your chosen lifestyle. Naturally, your chosen lifestyle should be based on your means, but some persons push the envelope too far.
While determining your retirement spending is inherently speculative, it leaves you better prepared to face the plethora retirement challenges. In addition, you can assess the effect of financial retirement risks on your spending and lifestyle during your golden years.
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